All in the Family

Mrinmoy Dey | January, 2011

From the local kirana shops to nation’s largest breweries, Indian Inc. is dominated by family businesses. Amidst scores of names that keep the flag of family business high, only a few have been able to create leadership synergy through knitting the family members together and avoiding any major clashes! The success of family business is directly proportional to values and emotional bondage a family has. It is sad but true that only 13% of family businesses in India survive till third generation which further drops down to 4% beyond the third generation. Most start-ups begin as a family business; therefore promoting entrepreneurship is directly linked to promoting family business. So, let’s introspect the rationale behind such a phenomenon.
 
Family business connection may yield unique advantages in acquisition of resources and self-funding, to some extent. Family ties provide an added advantage in opportunity identification because of family members’ greater willingness to share information with each other. But some unique challenges also come across as a part and parcel of such firms. The most prevalent predicaments in family businesses are conflicts and succession (Reliance family feud and Ranbaxy family feud are case in point). In fact, the success of a family business depends more on effective management of the overlap between family and business than on modus operandi of the business systems.
 
Transferring the values and business knowledge of the founders to future generations becomes more difficult as the family grows. They seem to struggle to keep all the members united and their interests should be aligned over the years. It further deteriorates with each passing generation. When families reach the third or fourth generation, their members may barely know each other – making it almost impossible to maintain aligned interests within a large family. Succession is probably the most significant issue a family business has to cope up with. Intergenerational transfer is not a onetime activity but needs to be carefully planned. Ownership of a family business is not perceived as a liquid asset but as a property which is nurtured and developed over generations. Moreover, the challenge faced by a firm in third generation with larger family size and company size would be much more tedious than the one faced by the firms which are in the first generation – run typically by the sole owner. Most importantly, it is not only the ownership but also the knowledge gathered over generations that is at stake.
 
However, you can bet your boots that the nuisance is not restricted to only these two challenges. Typically, in the early and start-up stages of the family business, company’s and family’s assets are not legally separated – it complicates the situation further and raises conflicts of priority (between family and business). For instance, Brent Redstone took his father and sister to court over ownership issues. Even Mafatlal's family saw similar family feud. 
 
 
 
 
As and when the business starts growing up, it becomes imperative to attract well-qualified professionals. But, family business firms often find it difficult to attract good specialists to assume executive positions. Above all, negative perception of the skilled professional over the issue of ‘career progression’ does not help either – as they are perceived as an organization where non-family member will be at a disadvantage all the time as compared to a family member (even if the latter is less suited for the job). In fact, family control exhibits specific weaknesses when descendants are involved in the top management. Stock market reacts negatively to the appointment of family heirs as managers (as per a study conducted by Perez-Gonzalez and published in American Economic Review titled 'Inherited control and firm performance'). To top it up, the emotional string attached with the family members make it extremely difficult to shed human resources that eventually leave negative impacts on the overall economic performance of the firms. The situation just becomes worse for the small firms.
 
Another challenge is fund raising and the associated fiscal bias on whether to rely on equity finance or debt finance. Moreover, owner-manager of privately held family firms tends to be reluctant to involve external investors. They might end up selecting a funding option which might not be an optimal choice as far as the cost of fund is concerned but a fund that would not erode their control over the business. It’s true that family firms have very limited access to capital market but then they even consider external equity as the last resort. A report of emerging market firms published by the Citigroup Global Markets (2007) suggests that investors place a 3% valuation premium on firms in which family insiders wield significant but not absolute control. On the contrary, investors assign a valuation discount of 5-20% in case of firms where families are majority owners. One of the characteristics of family business is their long-term sustainability – often associated with cautious risk-taking behaviour which ultimately impacts their financial decision.
 
On a positive note, Credit Suisse research indicates that family owned companies tend to perform better over the long term and generates superior returns and higher profitability than their counterparts. Long-term strategic focus instead of focus on quarterly results is the key to success for the family business firms. 
 

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